A clean up team for the Flying Debris Squad of the Navi Mumbai Municipal Corporation (NMMC), collect garbage dumped on the side of a road in Navi Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

Empowering RBI To Clean Up The Bad Loan Mess. Will It Work?

It’s the latest attempt to resolve close to Rs 10 lakh crore in stressed assets sitting on the books of Indian banks, mostly state-owned lenders. Having forced the recognition of bad loans through the asset quality review (AQR) conducted in 2015, the Reserve Bank of India (RBI) and the government are now attempting to fast track the resolution process.

An amendment to the Banking Regulation Act, via the ordinance route, has given the RBI powers to intervene and decide on resolution of specific stressed loan accounts. It empowers the RBI to issue directions to banks on resolution of stressed assets. It may also direct banks to initiate an insolvency resolution process in the case of a default. The RBI may also constitute committees that advise banks on stress resolution, as per the Ordinance.

With the Ordinance cleared, the RBI will issue a new framework for distressed asset resolution. The likely resolution process will involve a time-bound structure within which stressed assets have to be resolved, according to a person familiar with the matter. Banks and the company concerned will be asked to come up with a decision within a specific time frame, the person said.

If banks can't act in a timely manner owing to any delays, then a committee, which will have some involvement of the RBI, will take a final call on the resolution plan for that company. In most cases, this would be done through the Bankruptcy Code.

BloombergQuint spoke to bankers and analysts to understand whether this will help quicken the resolution process.

More Comfort For Bankers?

One of the reasons that banks have shied away from taking tough decisions related to haircuts needed on stressed loans is the fear of being questioned later. Some bankers feel that RBI-mandated committees would make it easier for banks to take such calls.

Extreme situations require extreme actions and this is an action in the right direction. Ideally in a market led economy, it should be the market that determines any decisions. Unfortunately, we haven’t reached that kind of development in the market..The formation of oversight committees will give banks a lot more confidence when taking a commercial call on stressed assets.
Sunil Srivastava, Deputy Managing Director, State Bank of India

Papia Sengupta, executive director at Bank of Baroda took a similar view but felt that the Ordinance is, so far, an advisory.

The laws allowing RBI to issue directives were always there. We feel that this ordinance is just an advisory. The creation of committees, however, will be helpful since there will be a second voice validating our decision. It abates the fear of prosecution by investigative agencies.
Papia Sengupta, Executive Director, Bank of Baroda

NS Venkatesh, executive director at Lakshmi Vilas Bank, said that he expects the RBI to set up sector-specific expert committees, which will guide banks on how to tackle stressed loans in a particular sector.

As banks move to resolve large bad loans, they may need additional capital to provision against the likely hit. Venkatesh said that banks will be in a better position to raise capital after their balance sheets are cleaned up.

With respect to the likely capital hit to banks, if the process of resolution of large stressed accounts is accelerated, it is better to pursue resolution first and then look for fresh capital... In this case, the market will reward quick resolution of bad loans. Capital should be utilised for growth and not to chase bad loans.
NS Venkatesh, Executive Director, Lakshmi Vilas Bank

Positive For Banks But...

Analysts and rating agency executives feel the move is positive for banks as it speeds up a resolution process that was moving as snail’s pace. Some, however, question whether buyers will emerge for stressed accounts, while others question whether banks will have enough capital to take the hit.

This is positive, because banks can go for deeper discounting without worrying about being investigated. 50 percent of the stress is in infrastructure – thermal power, toll roads and telecom companies. There is inherent viability in these projects. If some of these are sold with an effective haircut, they could be brought back to life.
Abhishek Bhattacharya, Director, India Ratings & Research

Rakesh Kumar of Elara Capital raises a question on whether there are enough buyers in the market.

There is nothing surprising or substantial in today’s announcement. The larger concern is that even after making an account insolvent, where is the buyer to buy that account?
Rakesh Kumar, Banking Analyst, Elara Capital

Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services Llp, said that what will push the process further is the comfort that bankers will get. “If the RBI provides a mechanism, where haircuts are approved, so that nothing is investigated later by investigating agencies, it would be a very positive move,” said Parekh.

Is This A Conflict For The RBI?

Former central bankers expressed some discomfort with the RBI directly intervening in the bad loan resolution process.

A former RBI official, who spoke on the condition of anonymity, said that on the face of it asking the regulator to take decisions on bad loans could prove to be a conflict of interest. However, it must also be acknowledged that the bad loan problem is severe and something was needed to break the cycle, said this person. He added that the RBI still has a reputation of great integrity, which may limit finger pointing at decisions taken by it.

KC Chakrabarty, former deputy governor of RBI said that further clarity is needed on the role of the RBI. He, however, added that the regulator’s involvement in resolving bad loans does not attack the root of the problem.

We still need to clarify what will be the nature of the directions that the RBI will issue when dealing with stressed loans. We have read somewhere that only the top NPA cases will be targeted. Why is that? If there is an epidemic in a village, you do not just treat five of the people there. You must treat everyone. To meaningfully deal with the NPA crisis, we must understand the reason behind NPA and devise a strategy that will work around the problem.
KC Chakraborty, Former Deputy Governor, Reserve Bank of India